Trick or treat! When you think about it, corporate earnings season is similar to that children’s favourite, Halloween.
Expectations usually run high, but you never know if the door you are knocking on will yield a delicious surprise or be a complete let-down, as the sweets are either from last year or there’s none left.
So far the haul for investors (at least Stateside) has been mixed.
We have witnessed US banks reporting strong earnings, buoyed in part by bond trading in the aftermath of Brexit. But apart from the banks and the usual tech darlings, Richard Saldanha of Aviva Investors points out in an analyst note that we have seen a raft of profit warnings from industrials including Honeywell, Dover Corp and PPG that are “highlighting broad based weakness in the manufacturing economy”.
With the energy sector still depressing overall S&P earnings – despite the recovery in oil prices – analysts agree that we will have to wait to see strong bottom-line growth returning to US and European companies. S&P Global Market Intelligence data, reported in the FT, predicted profit growth of just 0.63 per cent for US firms for this quarter.
As Saldanha states, the expectation is for a “return to growth in the fourth quarter, and expectations for double-digit earnings growth in 2017 on both sides of Atlantic”.
So is that a clear buy signal?
Not necessarily. Saldanha adds: “The problem you have right now is that equity valuations (particularly in the US) don’t leave much room for disappointment (i.e earnings growth is getting priced in) so for markets to push higher from here essentially we need to see evidence of earnings coming through (i.e it’s a show-me quarter).”
Peter Garnry, head of equity strategy at Saxo Bank, is equally cautious. “We are slightly bullish on equities, but worried about valuations because it makes equities vulnerable to shocks,” he wrote in a note. He adds that the third quarter earnings season is important because “analysts are expecting 38 per cent and 20 per cent EPS (earnings per share) growth in the MSCI World and S&P 500 respectively over the next 12 months.” But he thinks that it “still seems like an elevated target”.
And some think the candy – sorry, earnings – investors are getting on this side of the pond are not so sweet to begin with. Goldman Sachs’s European Equity strategy team wrote this month: “European profits have not recovered since the global financial crisis, neither in terms of level nor pace. Earnings estimates have been revised down by 11 per cent since the beginning of the year, which is the largest revision the market has seen since 2009, questioning the credibility of earnings estimates.”
The team says the underlying reason for this is the sector composition of the Stoxx Europe 600, in which financials and energy are heavily overweighted in relation to their actual economic significance. Second, buybacks have not given European stocks as much of a tailwind as they have done for their US peers. And third, there are deflationary forces in the stock market.
If you want to avoid a spooky surprise this Halloween, you may not want to bet on earnings to be the catalyst to drive equities higher. Alternatively you can manage your expectations for returns, your own in the stock market or your kids’ when it comes to Halloween. They might learn a lesson they can use later in life.